MIBs: Microfinance Investment Barbarians

Private capital to microfinance is mostly channelled through gatekeepers (microfinance investment vehicles – MIVs). Some public capital also flows through these vehicles. On the micro scale the P2Ps (Kiva, MyC4 etc) act as more trivial gatekeepers for those wishing to obtain the feel-good factor of having a photo accompany their $25 investment. MIVs are often located in tax-havens to “minimize” tax and disclosure rules. They are opaque creatures – visit the website of any MIV and you will be surprised how little information is provided.

Academics focus on the effectiveness, or lack thereof, of microfinance in the field, but my focus has been rather on these gatekeepers – funds, or Barbarians as they were referred to in the classic 1990 book. This is not because I feel the question of whether microfinance actually works or not to be unimportant, but rather that this prior-stage of the overall investment chain is often overlooked.

The P2Ps are in a dangerous race to the bottom, and furiously trying to reinvent themselves. In the case of Kiva the benefit of interest-free capital for the microfinance institution (MFI), but with the headache of inventing little stories and sending photos to California, is only attractive to MFIs unable to tap reasonably priced capital from the MIVs. Why would they be unable to attract funding from MIVs who can barely invest their funds under management? Because such banks are trivially small, mediocre, or questionable to be deemed attractive by those on the real Wall Street of microfinance – the MIVs.

But the MIVs are bleeding currently. Dan Rozas’s article on BlueOrchard did the rounds. Once the big swinging dicks of the MIV sector, BlueOrchard has lost about half its funds under management and is also trying to reinvent itself. Good luck to them – this can only be an improvement. SNS Bank invests in microfinance via Developing World Markets (DWM – “los tiburones”, or “the sharks”) of the sector, and via Triple Jump. SNS collapsed and was nationalized by the Dutch government at vast expense to the taxpayer. Another one bites the dust. Alas SNS owned ASN Bank – another embattled fund managed by Triple Jump, alongside Oxfam Novib, who appear to be withdrawing from microfinance discreetly. Bailouts and collapses, euphemistically referred to as “mergers” or “acquisitions” took out another couple of funds.

Recent regulatory changes hampered the attractiveness of such funds to retail investors, particularly in Holland. Microfinance is no longer considered an “ethical investment” for tax purposes, removing one key reason to invest in such funds. Investors in such funds were exempt from wealth tax on account of doing something “ethical” with their savings. Since January 2013 this exemption has vanished. This could be due to the Dutch government deciding microfinance is not in fact worthy of tax-exemption on the grounds of being ethical, or it could simply be a way for the government to increase tax revenues. Either way it doesn’t send a particularly encouraging signal to potential microfinance investors.

I called DWM recently in what transpired to be one of the most pointless conversations in recent memory. Everything is confidential. They have no opinion. They cannot tell you what day of the week it is. They refuse to disclose any information. I do not know why they bother having an email address and telephone on their website at all. The information on their website and in the few documents available is negligible and useless. In fact, when the information content of a website approaches zero one must also wonder why they bother having a website at all. A totally private club. Endorsing all the usual transparency initiatives of course! I shan’t waste more text on DWM.

Progressive governments such as Ecuador slapped on taxes on all capital obtained from foreign MIVs in an effort to prompt microfinance institutions to source local funding, particularly by encouraging, or forcing MFIs to become regulated and capture savings locally for lack of a reasonably priced alternative. If the MIV is located in a tax haven there is yet another tax. Taking capital at 9% from a Luxembourg-based MIV while operating under an interest rate cap of 30% is an unattractive option for an MFI. Expect other countries are likely to follow, particularly those with left-of-centre governments (Bolivia, Peru perhaps). In countries where microfinance over-saturation is a risk this is a convenient way for governments to simultaneously raise tax, calm the MF sector, oblige more players to become regulated and start offering the poor savings-services, which are actually rather useful. However, overtly populist measures can harm genuine MFIs in the process – it’s a delicate balancing act and one that Rafael Correa in Ecuador appears to have performed rather well.

Add to all this the mounting wave of criticism of microfinance in general and the MIVs face a serious challenge. How to continue growing in a sector being hammered on all sides? There are a few who simply deny the problem (Grameen Foundation and that ilk of pseudo investment vehicle that remain convinced that world poverty is about to vanish if only more credit cards could be issued). Such players appear to ignore academic research, deny all charges against them and their sector, refuse to comment on anything remotely negative about microfinance, and rely on pure spin aimed at the lowest layer of unsophisticated, well-meaning but chronically unaware and naive investors. Frankly, with such utter stupidity so obviously visible at these spin-masters, it is hard to sympathise with them or their investors.

Kiva’s mere existence demonstrates the urgent need for financial literacy training in the developed countries as well as in remote corners of Africa. But what of the vaguely sensible funds, such as BlueOrchard, Incofin, Triple Jump, Deutshe Bank etc?

As far as I can see they face only a few key options – and this is nothing novel, merely the natural path that any investment fad follows.

Plan A – diversify: this is probably the most obvious choice – microcredit became a household name and then a dirty word, microfinance replaced it, now it’s terms like “financial inclusion”, “missing-middle”, “social enterprise”, “responsible investing”, “impact investing” and “SMEs”. A pig with lipstick is still a pig. Triple Jump recently ranted about precisely this novel direction – apparently this is the future of poverty alleviation, as declared by the same jesters who previously thought microfinance to be the miracle cure some years ago. But there is some truth in this line of reasoning – it is likely that wisely financing the tier above cigarette vendors and the 100th tomato vendor in the village might produce greater impact than traditional microfinance. It could even generate employment – that would be a perk. My main concern is that it is being performed by the same folk who messed up microfinance. But Bateman’s argument that we are doing little more than trivializing, or infantilizing the productive economies of these countries remains valid. In true Bateman style his latest piece was subtly entitled “destroying Latin American Economies from the bottom up”.

Can any of this work? That’s a question for another day.

Plan B – merge or acquire: I suspect we will see consolidation in the MIV sector. Margins are low, competition is fierce, scrutiny is tightening, MFIs are becoming more sophisticated, and investors in MIVs are becoming more discerning. Combining forces to exploit economies of scale and more rapidly reap the benefits of diversification is a sensible strategy. OFI recently bought a slice of BlueOrchard. MicroVest acquired Minlam.

As banks downscale into the microfinance sector and have sources of funding independent of the MIVs this will further crowd out the need for MIV funding. The second biggest MFI in Peru is CrediScotia – part of the massive global Canadian bank, and well able to raise capital cheaply on capital markets without having to rely on MIV funding. Likewise MFIs are transforming into banks and able to obtain funding locally or on capital markets, no longer requiring MIV capital so extensively. Consolidation is inevitable.

Plan C – become a niche player: MIVs not wishing to acquire or be acquired will target both niche MFIs and niche investors, and become “boutiques”, competing with the big boys neither to invest nor to attract capital. Faith-based funds have exploited this avenue for years. Expect to see more “energy/green/education/healthcare/education/one-legged women” etc. funds.

Plan D – move into the periphery: this is possibly one of the more exciting possible outcomes. Microfinance is arguably not as profitable as it once was, and yet all MFIs spend fortunes on mediocre software packages to supposedly manage their operations – someone is making a ton of money providing this software. Investing in such companies could be a wise idea. Kizoo recently invested in Mambu.

Or why not start offering acquisition finance to MFIs as this layer also consolidates? There’s not much competition in this niche, so margins will likely be higher. What about the media outlets reporting on the sector? As cloud-based IT solutions emerge the data-mining potential is huge, and potentially profitable. MFIs are increasingly encouraged, or obliged, to consult and report to credit bureaus, who manage a large database, get the data for free and charge the MFIs for each consultation. They are also natural monopolies, which would make most investors salivate. Any possibilities to invest in these?

There are obviously huge conflicts of interest for an MIV wishing to invest in a rating agency, but such conflicts have not prevented the sector to date. Planet Finance offers technical assistance to MFIs (in the process obtaining hard-to-obtain information), does Greenfield investments, advises investors and funds, has a rating agency, and no one complains about such glaring potential conflicts of interest. On Wall Street you’d risk a prison sentence. But investing in a rating agency could be a juicy investment, and it’s a quasi-monopoly with a few players. Alas they are not very profitable, but some strategic consolidation in this sector could enable some price increases.

And none of this is particularly new. FINCA obtained the MIS company SIEM a decade ago. Danish private equity fund Sophia nearly invested in US MIS company Kredits in 2011, but withdrew at the 11th hour. To date these have been strategic investments, and somewhat ad hoc. It is only a matter of time until one of the MIVs decides to set up a dedicated fund to invest specifically in such peripheral activities. Would it benefit the poor? Probably not, but that won’t keep the fund awake at night. But as soon as an MIV launches such an ethical, pro-poor fund investing in such activities I’ll apply for sure.

Conclusion

Transparency and regulation are the keys. The MIVs avoid both like the plague. If you hold the faintest glimmer of doubt about this, ask any MIV for a list of its investments and the APRs they charge. Even such glaringly obvious data has evaded each and every MIV. Triodos and a few others list their investments, no more. That’s it. DWM has a lovely map with dots on all the countries they’ve invested in, but clicking on the dot just says “Pakistan – 2 investments”. Transparency is for everyone apart from those who control the financing. For as long as this situation remains I cannot claim to lose much sleep over the demise of the MIVs. This is the most opaque part of a pretty murky sector, and as they slip down one or a combination of the paths listed above, I’ll watch with morbid curiosity.